I find that sector or thematic ETFs are suitable for satellite portfolios, or for making generally small bets on specific trends. However, they are not ideal for core, long-term holdings. This is due to the sector rotation effect present in both the market and the economy, implying that today’s top-performing sector might not retain its status tomorrow. Consequently, this requires precise timing to effectively buy and sell sector/thematic ETFs.
The semiconductor theme has defied the sector rotation theory, emerging as the best performing theme of the past decade.
Below is a screenshot from ETF.com showing the highest-returning ETFs over the last 10 years.
The top four are semiconductor ETFs, each boasting annual returns of over 20%.
Remarkably, the VanEck Semiconductor ETF (SMH) has even outperformed the impressive Invesco QQQ Trust (QQQ), with an annual excess return of 7.3% in the past 10 years.
Of course, this perspective is based on hindsight. Prudent investors would not concentrate their bets solely on a single theme. Instead, they might feel more comfortable owning a diversified tech ETF, or even broadening their scope beyond tech with an S&P 500 ETF.
Semiconductor chips, though crucial in our daily lives, were once perceived more as commodities. However, recent years have seen a paradigm shift, particularly due to the intensifying rivalry between the US and China, bringing semiconductors into sharp focus. If the Cold War era was marked by the space race between the Soviet Union and the US, the contemporary equivalent is the ‘chip war’ between the US and China.
Historically, most brand recognition was associated with consumer products from companies like Sony, Samsung, and Apple. The specifics of the chips used or their manufacturers were largely overlooked, with the notable exception of the ‘Intel Inside’ campaign, which did create a preference in the computing world.
Moreover, since Marc Andreessen’s seminal 2011 article ‘Why Software is Eating the World’, investor focus largely shifted towards software, under the belief that while hardware would remain a commodity, software would command future power. Indeed, software companies thrived, especially during the pandemic. However, they couldn’t sustain this performance over time. Contrarily, as demonstrated by the results mentioned earlier, investments in chip companies have proven far more lucrative.
Now, the semiconductor industry commands widespread attention. From leading fabricators like TSMC to chip designers such as Nvidia and equipment makers like ASML, every aspect of the semiconductor world is now under scrutiny.
This isn’t to downplay the importance of software, but rather to underscore the unpredictability surrounding the sudden surge in attention on chips. Such thematic bets often seem obvious only in hindsight.
Rewinding to around March 31, 2021, the landscape of the top 10 thematic ETFs paints a different picture. Notably absent were any semiconductor ETFs which means most thematic investors did not capitalize on the rise of semiconductor stocks. Instead, the spotlight was on ARK ETFs, fueled by the rising fame of Cathie Wood as a celebrity fund manager.
I’m not advising against thematic investing; rather, I’m pointing out its inherent unpredictability. There were more thematic ETFs that floundered and the success of semiconductor ETFs were the exception and not the norm.
For those considering investing in a theme, it would be prudent to allocate a smaller portion of their portfolio, rather than treating it as a core investment. Thematic investments often ride on current news trends. For instance, the AI theme is currently garnering significant attention. Investors should exercise caution, especially when expectations surrounding such themes are high.
